Stabilization Mechanism: Sticking Half Way through the Line

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Friday, August 24, 2018 6:00PM / Proshare Research


According to the 2017 International Monetary Fund’s Annual Reports on Exchange rate and Exchange to Restrictions - popularly referred to as “AREAER”; Nigeria ’s current exchange rate policy was tagged a “stabilized arrangement” since the Central Bank intervenes on multiple fronts, thus accommodating multiple exchange rates.


Table 1: Countries and Classification 

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The Exchange rate challenge experienced in Nigeria, can be traced back to when hard pegs were introduced in 2015, which led to a stabilizing arrangement that served as a measure of decoupling such hard pegs.  On one side of the street, reverting to multiple exchange rate allowed policy makers accommodate a partial “Dollar Ventilation” in an open economy so as to boost autonomous inflow. This began by letting the Naira bite the bullet, fused with the introduction of the Import and Export window.


In reality, this decision could only allow policy makers move half-way through regarding the exchange rate, as the presence of low interest rate in advanced economies served as a support to such policy at that particular point in time; reflecting no exposure to shocks to the financial account. It also put an end to the period of over shoots experienced in the Naira, therefore allowing price movement to be anchored by the official window compared to the past where the black market anchored price movement partially. 


However, on the other side of the street, the increase in oil prices and output provided the resources for monetary policy to intervene on several front and retain residue of price discrimination in its exchange rate policy.   The boost from the autonomous window further provided a breather for the bank to embark on such policy; thereby artificially suppressing prices while concurrently building up its reserves. The ability to suppress prices artificially and intervene on several front tagged such policy as a Stabilization Mechanism. At the same time  the  cost  of  this  stabilization  policy  denied  monetary  policy the ability to  carve out  an  appropriate real effective  exchange rate trajectory path.

Studies  have shown  that  in  countries with relatively no clear  real effective exchange rate trajectory fused  with time inconsistency  regarding  its foreign   exchange  has  left   foreign direct  investment lean. Meanwhile, the recent normalization in interest rate abroad largely referred to as “the soft side of the hawk” as the Federal Reserve Bank wind down its balance sheet while tilting upward its effective interest rate has put an end to an era of excess liquidity.


This new dynamic has dampened the activity in the Import and Exchange window, at the same time threatening the initial breather enjoyed by the Central bank thus reinforcing the emergence of shocks to the financial account.  In a follow up as the bank maintains its policy of intervening on several fronts, the   foreign reserves have begun to plummet, while the premium across several corridors has widened thereby putting pressure on the Naira. 


Unlike the “Tabila” regime which used stabilization mechanisms to guide public expectation, we have come short on such.  Moreover with conflicting tunes from the Central bank regarding foreign exchange, there is a need to completely decouple the peg at this point in order to unify the rate, eradicate elements of price discrimination in foreign exchange and achieve a real effective exchange rate path and build up reserves.      

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